Krugman and the Keynesian “Stones into Bread” Fallacy

The more I read Paul Krugman’s columns and papers, the more I realize just how great the gulf is between Austrian and Keynesian thought. It is impossible to sum up all of the differences between the two camps, but I do think that perhaps the disparities can be summed up in the Austrian rejection of Keynes’ famous 1943 statement that expansion of credit by the central bank will create a “miracle . . . of turning a stone into bread.”

In his column today, Krugman in a roundabout fashion repeats this notion, as he excoriates the governments of the world for not borrowing, printing, and spending at a rate that he believes will keep the world economy from slipping into depression. At the heart of Krugman’s exhortation is his belief that credit expansion is the same thing as creating wealth. I don’t think so.

Krugman has almost a religious belief that borrowing and printing money and policies of spending for the sake of spending will pull the country out of a recession. He writes of the current mess:

…this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

Krugman ignores the recoveries after the 1921 recession and the 1982 recession, both of which occurred in the absence of inflation and and the presence of higher interest rates. Furthermore, while the U.S. Government in both instances ran deficits, they were deficits brought on by the fall in tax revenues due to the recession, not as matters of “deficit-based stimulus” policies.

But, there is a larger issue here, and it is this: Current spending by government does not create wealth, and it is the creation of wealth that will bring us out of the depression. Borrowing from future generations (or repudiating the debt through inflation) is nothing more than making a claim on future wealth. Furthermore, Krugman’s recommendations do nothing to address the current set of malinvestments which plague the economy, not to mention the huge added burden of government-imposed costs which make production of wealth more difficult.

Lest we think that Krugman is saying something new, the great Ludwig von Mises more than 60 years ago exposed this faulty thinking. He wrote:

The stock-in-trade of all Socialist authors is the idea that there is potential plenty and that the substitution of socialism for capitalism would make it possible to give to everybody “according to his needs.” Other authors want to bring about this paradise by a reform of the monetary and credit system. As they see it, all that is lacking is more money and credit. They consider that the rate of interest is a phenomenon artificially created by the man-made scarcity of the “means of payment.”

In hundreds, even thousands, of books and pamphlets they passionately blame the “orthodox” economists for their reluctance to admit that inflationist and expansionist doctrines are sound. All evils, they repeat again and again, are caused by the erroneous teachings of the “dismal science” of economics and the “credit monopoly” of the bankers and usurers. To unchain money from the fetters of “restrictionism,” to create free money (Freigeld, in the terminology of Silvio Gesell) and to grant cheap or even gratuitous credit, is the main plank in their political platform.

Indeed, it was as though Professor Mises was anticipating Krugman’s arguments. No doubt, Krugman would think Mises was a fool and a charlatan, but the joke is on Krugman. True, Mises did not have a Nobel Prize; but Mises had wisdom, and that makes all the difference.

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About William L. Anderson 48 Articles

Affiliation: Frostburg State University

William L. Anderson is an author and an associate professor of economics at Frostburg State University in Maryland. He is also an adjunct scholar with the Mackinac Center for Public Policy as well as for the Ludwig von Mises Institute in Alabama.

Anderson was formerly a professor of economics at North Greenville College in Tigerville, South Carolina.

Visit: William Anderson's Blog

8 Comments on Krugman and the Keynesian “Stones into Bread” Fallacy

  1. So what's your suggestion? And how was Mr. Krugman wrong? Wealth vs. Spending creating jobs is old argument since the first world war, Austrian school had obviously lost the first debate – due to lack of counter argument of "how" or the process of how wealth create jobs or the theory of the creating jobs. Go further than just an ideology debate and go into the actual process: Enlighten us and make it a new mainstream if you think it is the right way – otherwise, it will just turn into a political mumble jumbo.

    • See much of Krugman's earlier work and support for Barry's overwrought spending/stimulus. Now that it's clear that neither was a good idea, Krugman should be lambasted for playing economist lackey, thus the story title and content.

    • Krugman was a highly paid Enron adviser. You know how that worked out. Krugman has been wrong on every economic prediction he's ever made. The best available policy is to do whatever he says will fail.

    • I'm not sure that was the intent of this article, but a lot the Austrian theories are mainstream and are the very foundations of Neoclassical schools today, (subjective theory of value, marginal utility, law of diminishing marginal utility, inability to measure interpersonal utility, Bom Bawerk's Interest Theory of time preference, Knut Wicksell's natural rate of interest, etc.)

      Where the "mainstream" Neoclassicals and Austrians particularly differ is:

      "Sticky" prices (i.e., prices don't readily adjust so the Fed has to move things along) vs. prices adjusting as a gradually unfolding process as individuals gain new information and unevenly adjust their activities to new market conditions.

      "Mainstream" economists look for rises and falls in aggregate data in static states, where Austrians dis-aggregate see constant shifts over time which underlie the aggregate data, e.g. between different industries, or between different products of different prices or between more capital intensive activities to less capital intensive, unemployment for different industries or in different stages of the production process, or even individual firms, etc.

      There are other differences, but largely, the Keynesian Revolution resulted from Keynes dismissing (not necessarily disproving) Say's Law from the "General Glut" debate of the early 19th century between Thomas Malthus and the Classical Economists.

      Keynesians believe that ineffective or lack of demand causes depressions (derived from Thomas Malthus) and that the Government must step in to make up for it.

      Austrians believe, in accordance with Say's Law (and the Ricardo school) that some firms have not produce in synch with consumer demand and savings preference or that firms have misjudged how much customers are wiling to pay for their products, and must adjust their prices or their production processes to meet customer demand in order for the economy to recover.

      • There have been improvements under Mises and Hayek with the Austrian Theory of the Business cycle, incorporating the natural interest rate, which coordinates savings with investment across time.

        Naturally, the higher the savings, the lower the interest rate and more capital intensive activities can been conducted. But an ARTIFICIALLY low interest is a price ceiling that increases demand for more capital intensive investment but decreases demand for saving (price controls below "the market level" overstimulate demand and discourage supply).

        The boom is overstimulated demand for capital intensive investment (full employment for Neoclassicals who see this as the solution for economic growth). But the during the boom, the supply of savings is discouraged since return on investment is too low (low dividends, low interest payments, high P/E ratios, etc.). "Excessive" leverage can be taken on in order to maximize investment returns that are too low with "normal" leverage.

        The bust is the realization that the supply of savings is not sufficient to warrant some of the investments taken on. Recovery occurs as the natural rate is restored and savings and investment are restructured and equilibrated to meet consumer time preferences (i.e., the price control is removed supply and demand move back towards "equilibrium").

        • Also, in the "real" economy, real productive resources (i.e., land, labor and capital) are redirected to and rearranged in capital intensive markets (time consuming) and away from productive lines closer in time to consumers (consumer goods). During the bust, land labor and captial are again rearranged from the capital intensive markets (where production does not meet consumer preference) back to more consumer oriented markets (where "real" consumer demand actually is).

          So rather than "ineffective" demand being the issue, for Austrians (in accordance with Say's Law) it's that some production lines do not meet consumer demand and time preference. These particular production lines must liquidate and restructure to meet consumer demand and time preference.

  2. I agree with Roy. This just seems like a lot more of "Liberals/Socialists are wrong but we have no alternatives!"

    I have actively searched Google for a counter proposal to Krugman's article today, and have yet to find one…

  3. You can call the Keynesian position religious fervor if you want, but there's a rational argument behind it. Incidentally, there's a rational argument behind the counterpoint as well (try Wikipedia for starters:… but I've never heard it mentioned by commentators from the right, most likely because waving around ideological pabulum has taken the place of informed discourse about economic theory in most of the popular press today.

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